A little more light please

If India wants to progress, the government will have to rationalise and modernise the power sector, especially the distribution end of the generation-transmission-distribution chain. The deteriorating financial health of the power distribution entities has led to inadequate investments in the sector and this has led to shortfall and poor quality of power supply.

Here is a figure that will explain the situation: in 2011-12, the combined financial losses of the power distribution companies were Rs 1,20,000 crore or about 1.5% of India’s GDP. These losses arose from the rising gap between the average cost of supply and the average realisation. The distribution companies are losing Rs 2 for every unit of electricity sold by them.

It is well-known that the issue of tariff hikes in the power sector is politically sensitive. The fact is that many states have not revised tariffs in the past five to six years, and some for even over a decade. With the average cost of supply growing at over 7%, the situation has become untenable.

In order to meet their operating costs and ensure reliable supply, the distribution entities — in public and private sectors — require tariff hikes of 50-60%.

An increase of this magnitude will seem staggering to the political leadership and consumers. But the fact is that this hike will still not address adequately the issue of huge losses, which have accumulated over a period of time, due to irrationally low tariffs.

It is equally important to take note of the recent positive signs from the government and policy-makers on tariff reforms. Even before the current financial year began, seven states revised power tariffs by as much as 7% to 37%; nine more states have filed for tariff revision petitions and are expected to announce new rates for the sale of power in the near future. One factor that has led to this more rational view has to do with the stringent measures made mandatory by banks and non-banking financial corporations for the disbursal of fresh loans to the distribution companies and the empowerment of state power regulators to revise tariffs by the relevant appellate tribunals.

The logic behind the rationalisation of power tariffs has to be put to work on a perennial basis. This implies putting in place permanent mechanisms and practices that can pass on any variation in power costs to consumers. The critical consideration here is that purchase costs for power typically constitute up to 80% of the total cost of the distribution operation. Since the ‘truing up’ process, involving a fix on the gap between cost of power purchases and the revenues from sales, can take as much as a few years for reasonable estimation, it is important to institute and implement mechanisms that enable the immediate pass through of any variation in power costs. This will prevent the build up of the so-called ‘regulatory assets’ (actually amounting to current operating losses) and cash flow problems, an excruciating experience for most distribution companies at present.

Delhi is a good example of what can be done and what can be undone if tariff rationalisation lags behind other reforms in the power sector. The entry of private distribution companies has led to a remarkable turnaround in the state’s power supply: aggregate technical and commercial (AT&C) losses have come down from an annual average of over 60% to around 15%, alongside a dramatic improvement in quality and reliability of supply, as well as vastly better customer care services.

Yet, all improvements and reforms in the Delhi electricity supply market are under risk for want of urgent tariff rationalisation. Stagnant tariffs over a period of time have led to a huge build up of future receivables (regulatory assets), impacting sustainability of operations for all distribution businesses in the capital city. Clearly, we have to find a national will towards cost reflective tariffs.